The Audit Risk Model
Lanfei Gao, Michael Andrews, and Shanaka DeSilva,
Audit Risk
• The risk that the auditor may unknowingly
fail to appropriately modify the opinion on
financial statements that are materially
misstated
• First fundamental concept of audit
procedures
Contents of Audit Risk
Detailed level:
– Account Balance
– Class of Transactions
Assertion
– Material Misstatement Risk
-Inherent risk
-Control risk
– Detection risk
Engagement Risk
• An auditor’s exposure to financial loss and
damage to professional reputation.
– client and third party lawsuits
– negative publicity
Audit Risk Model
• Inherent risk (IR) – The likelihood that a
material
misstatement exist.
• Control risk (CR)- Risk that the misstatement will
not be prevented, or detected and corrected on a timely
basis by the entity's internal control.
– Risk Material Misstatement; RMM = CR x IR
• Detection risk (DR) – Effectiveness of the audit
procedure.
Audit Risk Model
Audit Risk Model Equation:
AR = RMM x DR
• Requires professional judgment
– Highly subjective
• Not intended to be a precise formula
How to Use the Audit Risk Model
Limitations of the Audit Risk Model
• The desired level of audit risk may not
actually be achieved
• It does not consider potential auditor error
• Does not consider nonsampling risk
Thank You!
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